Many individuals want to make sure that part of their estate is dedicated to their favorite charitable causes, and many make the move to guarantee this during their lifetime. There are several ways to do this. Some individuals may consider structuring an endowment while other may choose deferred gifts or planned giving. Another vehicle to ensure your charitable wishes are carried out can include the creation of a private foundation. However, for some people, the best option for charitable donations during one’s lifetime and after might be to create a donor advised fund.
The Basics of a Donor Advised Fund
When we give to various charities, their tax status allows us to take advantage of a tax deduction. However, in order for our donations to qualify as tax deductible, the organization must typically be registered as what is known as a 501(c)(3) organization. These types of organizations must comply with certain rules established by the IRS, including restricted political and legislative activity while following other important guidelines. The IRS defines a donor advised fund as a fund or account that is maintained and operated by a 501(c)(3) organization known as the sponsoring organization.
With these funds, a donor is free to make contributions to this fund pursuant to the operating organization’s rules and regulations for such funds in compliance with United States tax law, at which point the sponsoring organization is considered to have legal control over the donation. However, a donor advised fund allows the donor or a representative of the donor to retain advisory privileges over how the assets in the donor advised fund are spent. In other words, while the sponsoring organization will ultimately determine the way in which assets from a donor advised fund are spent, donors are able to provide substantial input as to their wishes for how such funds will be spent. This can help individuals and their estates monitor exactly how their charitable contributions are sued while providing for an immediate tax deduction at the creation of the fund, subsequent tax deductions with continued contributions to the fund, and a deduction from one’s total estate value with donations to the fund from an estate after a donor’s death.
Drawbacks of Donor Advised Funds
These funds can be abused by individuals working with questionable private charities as a way to create tax shelters and other illegal mechanisms to shield assets from taxes. In such cases, sever penalties and taxes can be imposed by the IRS. In some cases, these penalties may put a donor’s assets at more risk than were they to be taxed regularly. It is important to ensure that any organization you work with to create a donor advised fund has experience in their creation and maintenance to avoid unintended tax consequences. The IRS has established strict requirements for donor advised funds, which can be accessed by clicking here.
Typical charitable contribution deduction limits will apply to a donor advised fund, so you can only take advantage of a tax deduction as far as the law allows. The IRS also places restrictions on what donor advised funds can be used for. Additionally, while setting up a donor advised fund can be cheaper and easier initially than establishing a private foundation, they can often come with management fees depending on how they are structured. These fees over time can eat away at the donated money in the fund, lessening the charitable impact your donation can have. An experienced estate planning attorney can work with you to understand the advantages and disadvantages of a donor advised fund so that you can determine whether it might be the right option to include in your estate planning.